C.R.L. Narasimhan

Don't write off the U.S. economy for now

Y. Venugopal Reddy , who was the 21st Governor of the Reserve Bank of India from September 2003 to September 2008, won international acclaim for his deft handling of India's monetary and external sector policies that famously saved the country from the worst consequences of the global financial and economic crisis of the period 2007-09. After retiring from that post, he has chosen to be an academic, and is now Emeritus Professor, University of Hyderabad. Widely consulted and listened to by many international organisations, Dr. Reddy is a brilliant commentator on contemporary economic issues. The downgrade of U.S. sovereign debt and the burgeoning debt crisis in the eurozone, have created fears of another global recession. Stock markets everywhere, including in India, tumbled. It is against this backdrop that Dr. Reddy answered, through e-mail, a set of questions put to him by C.R.L. Narasimhan.

Do you see some common points between the stock market collapse now and the start of the financial crisis in 2008? For instance, American policy making has been faulted both times — the weak regulation in 1997-98 and the complete absence of a political “give and take” now.

I agree with you that the crisis of 2008 and the incident or event of 2011, are somewhat similar. However, the crisis of 2008 was due to the wrong policies of the past, while the recent event is a failure of policy response to the crisis in the United States. Second, the recent event is not a new crisis; it is a continuation of the old one. Earlier everybody was taken by surprise, while the recent questionable downgrading invited attention to the weak and fragile economic recovery in the U.S. and the inadequate policy response. Finally, the crisis of 2008 was both due to wrong policies in a bipartisan manner based on wrong ideology, and the conduct of financial markets. The recent event is, in a way, due to polarised views on policy and also the result of the “make-believe world” of recovery that has been carefully projected by financial markets, resulting in a disconnect between the real economy and the financial markets.

The leadership role that was automatically bestowed on the U.S. has been called into question yet again. Are such calls once again premature?

[ Here he first commented on the U.S. currency being the world's reserve currency, the U.S. role in the recovery phase in the G20 countries, and related issues.] I agree that the leadership of the U.S. has been questioned before, but the questioning of its leadership this time is more serious. On earlier occasions, the policies were a reflection of inappropriate economic considerations, whereas the recent event shows an element of loss of confidence in the economic leadership of the U.S. both at the national and global levels. It is premature in the sense that the predominance of the U.S. will continue since its relative position, relative to other countries such as the euro area and Japan, remains to be significantly superior, as before.

In brief, the U.S. continues to be a pre-eminent leader for now, but a weaker leader than before, but with significant resilience and potential for assertion in the future. The intellectual capital, the institutional strengths and the value of the external assets of the corporate sector provide the U.S. with strengths that could potentially be harnessed. If it fails, it will hurt both the U.S. [economy] and the global economy.

The U.S. budget-related crisis and the debt crisis in the eurozone have some common features. Both of them are rooted in politics but have global ramifications.

There is a difference between the two, though both are related to public debt. In the U.S., it is essentially a political will at a national level to manage public debt with the centralised fiscal authority that it has. Further, the dollar is a primary dominant reserve currency, while the euro is a secondary reserve currency. In regard to the euro, there are important institutional constraints for distributing the burden between different sovereign nations that constitute the eurozone, and between the banking systems of individual countries legally and a constrained central bank. Single monetary [systems], coupled with multiple fiscal regimes, create substantial difficulties for designing the solutions, which will have to be innovative. While the challenge for the eurozone is more complex, the ramifications of the issue for the rest of the world are less severe. The euro area as a whole has no serious economic imbalances vis-à-vis the rest of the world. Most of the borrowers and lenders involved in the euro debt crisis are within the eurozone. In regard to the U.S., the rest of the world holds a significant part of the U.S. sovereign debt.

The “decoupling” theory, which says that fast-growing economies such as India need not depend on global cues, was discredited even last time.

The decoupling theory was developed soon after the financial crisis erupted in the U.S. and the euro area in 2007-08. I had described this at that time as “contextually convenient, but inherently illogical.” We cannot extol the virtues of globalisation when the global economy is booming, and suddenly discover decoupling when there are problems. The issue is an extent and a pattern of interdependence between the countries in regard to trade in goods as well as services and financial flows. It is also dependent on the extent of initial conditions of vulnerability or resilience of the economy concerned and the institutional capacities which provide space for public policy.

Is India as well placed as last time to cope with the consequences of the crisis? What additional steps would you recommend?

There is a difference between the crisis of 2008 and the event of 2011. We had a balanced economy, and, therefore, we could withstand the impact of the crisis better than many others. However, the initial position in 2011 for India is different from [that in] 2008. Our fiscal position is weaker both in quantity and quality. The external sector position is weaker both in terms of stock of assets and liabilities, be it quantity-wise or quality-wise, and flows in terms of current account deficits. Domestically, both public and private investments seem to be somewhat subdued, while supply inelasticities have set in. Above all, in 2008, we entered the crisis with confidence in terms of both growth and inflation, while the sentiment today is less confident than before. The redeeming feature, perhaps, is that the events in 2011 may not indicate a serious crisis, but would indicate uncertainties, volatilities, divergent growth paths, divergent policies, etc. The challenges for policymakers are different, way forward.

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